A stock or share, sometimes known as “equity”, is a financial instrument that reflects ownership in a firm or organization and a proportionate hold on its assets (what it owns) and earnings (what it generates in profits).
Stock ownership entails owning a piece of the firm equal to the number of shares owned as a percentage of the total number of outstanding shares. An individual or entity who holds 100,000 shares of a corporation with one million outstanding shares, for example, owns 10% of the firm. The majority of corporations have outstanding shares in the millions or billions of dollars.
Common and Preferred Stock
While there are two forms of stock: common and preferred, the word “equities” refers to common shares since their aggregate market value and trading volume are many orders of magnitude more than preferred shares.
The primary difference between the two is that common shares typically come with voting rights, which allow the common shareholder to participate in company meetings and vote on things like a board of director elections and auditor appointments, whereas preferred shares usually do not. Preferred shares are so named because they have priority over common shares in receiving dividends and assets in the event of a company’s bankruptcy.
The voting rights of common stock can be divided into two categories. While the basic idea of common shares is that they should all have the same voting rights (one vote per share owned), some businesses have dual or multiple classes of stock, each with separate voting rights. Class A shares, for example, may have ten votes per share, whereas Class B “subordinate voting” shares may only have one vote per share under a dual-class structure. The founders of a firm can control its fortunes, strategic direction, and capacity to innovate using dual- or multiple-class share arrangements.
Why a Company Issues Shares
Today’s corporate behemoth was most likely founded as a tiny private company by a visionary entrepreneur a few decades ago. Consider Jack Ma’s incubation of Alibaba Group Holding Limited (BABA) from his Hangzhou apartment in 1999 or Mark Zuckerberg’s establishment of Facebook, Inc. (FB) from his Harvard University dorm room in 2004. Within a few decades, technology behemoths like these have risen to become among the world’s most powerful corporations.
Yet, developing at such a breakneck speed necessitates a large infusion of cash. To go from an idea in an entrepreneur’s head to a functioning business, they will need to rent an office or factory, hire workers, purchase equipment and raw materials, and set up a sales and distribution network, among other things. Depending on the size and breadth of the firm, these resources will necessitate a substantial amount of cash.
A business can either sell shares (equity financing) or borrow money (debt financing) to raise cash. Debt funding can be difficult for a startup since it may have few assets to put as collateral for a loan, especially in areas like technology or biotechnology where physical assets are few. Furthermore, the loan’s interest would be a financial strain in the early stages of the business, when the company may not have any revenues or profitability.
As a result, for most companies in need of funding, equity financing is the favored option. To get the firm off the ground, the entrepreneur may use personal savings as well as cash from friends and family. As the company grows and additional cash is needed, the entrepreneur may turn to angel investors and venture capital companies for help.
When a business is starting, it may require considerably more cash than it can receive through continuous operations or a typical bank loan. It can do so by selling stock to the general public in an initial public offering (IPO). This alters the company’s status from a privately owned corporation with a few shareholders to a publicly listed company with shares held by many members of the general public. The IPO also gives early investors in the firm the option to cash out a portion of their share, sometimes for a large profit.
The price of the company’s shares will fluctuate after they are listed on a stock market and trading begins, as investors and traders analyze and reassess their inherent worth. There are numerous other ratios and measures that may be used to value companies, but the Price/Earnings (PE) ratio is arguably the most common. Stock analysis is further divided into two categories: fundamental analysis and technical analysis.